Oil & Gas (Neutral) - False signal or recovery?

Highlights

OPEC U-turn. In
contrast to its previous stance of protecting market share by pumping
more, OPEC has indicated in a recent meeting in Algeria that it could
cut its oil output by 240,000-700,000/day to stabilize the oil market.
Exact details on the production cut would be clarified in the upcoming
meeting in Vienna on 30 Nov whereby cuts in each member countries would
be decided. We believe our range forecast for Brent of between USD50-
60/bbl would still be valid given USD60/bbl would be the estimated
breakeven for US shale oil.

Cut could be self-defeating. While
any output cut is positive for market sentiment, the proposed cut could
be undermined by 3 main issues: (i) 3 major countries are exempted from
the cut namely Iran, Nigeria & Libya of which the output increases
could offset the proposed cut, (ii) OPEC oil production is still at
8-year high at this juncture and a cut of that magnitude might not be
sufficient, and (iii) with oil prices rallying, US shale producers could
easily ramp up their production within 6 months due to their short oil
investment cycle.

Impact to O&G players. We believe the abovementioned news would not be sufficient to improve local O&G services players’ earnings
as the anticipated oil prices improvement is not expected to lift oil
producers’ CAPEX significantly at least in the medium term. The only
company which would be directly impacted by oil price movement in our
coverage universe would be SKPETRO. According to our sensitivity
analysis, an incremental USD10/bbl improvement in Brent oil prices would
bring about 42% increase in our current earnings forecast.

Valuation impact? For
asset based players which are valued using PBV method, every 0.1x
increase in target multiple would bring 15-30% improvement in our fair
values for local O&G companies. As for PER-driven companies, every
1x increase would improve our target prices for companies by 10-15%.

OPEC cut will not rerate valuation. We
do not believe that the current development would bring about a
rerating to the overall industry as CAPEX spending is not expected to
improve significantly while upstream industry still has to face asset
oversupply overhang in the time being. Our house still maintains the
view that recovery for the industry would be slow next year with
activities expected to pick up but not sufficient to change the current
fundamentals of the O&G industry.

Catalysts

Weaker than expected oil production growth.

Risks

Further slump in oil prices.

Significant supply overhang in jack up rig market

Rating

NEUTRAL

Positives – Lower CAPEX from oil producers reining in oil production.

Negatives – Persistent oversupply in the market.

Source: Hong Leong Investment Bank Research - 17 Oct 2016

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